Strategic Cost Management

Introduction
 Cost Accounting

• Traditionally viewed as a process of assessing the financial impact of alternative managerial 
decisions
•  Establishes budget and actual cost of operations, processes, departments or product and the 
analysis of variances, profitability or social use of funds
•  
• Important tool used is “variance analysis” to show the variation b/w actual cost and standard 
costs
•  
– volume variation
 
– Material cost variation

– Labor cost variation

• Limitations felt in using variance analysis
•  
– Why costs were different from what was planned?
•  
– Lack of integration with organizational goal
Limitations in management accounting 
and conventional cost accounting 
• Cost analysis in terms of products, customers and functions
• Strongly internal focus
•  
• Basic objective in identifying the cost is
•  
– Score keeping (recording and compliance of the profession)
– Attention directing
– Problem solving
• Cost is assumed as a function of output volume (variable cost, fixed cost and mixed cost)
•  
• Standard cost system with normal allowance for scrap, waste, rework; zero defect standard is not 
practical.
• Overhead variance analysis; maximize production volume (not quality) to absorb overhead.
•  
• Variance analysis on raw material price; procedure from multiple suppliers to avoid unfavorable price 
variance; low price/low- quality raw materials
•  
• No emphasis on nonfinancial performance measure
 Why SCM?
• It is cost analysis in a broader context, where the strategic elements become more conscious, 
explicit, and formal
• Cost data is used to develop superior strategies in route to gaining sustainable competitive 
advantage

• SCM gives a clear understanding of the firm’s cost structure in search of sustainable competitive 
advantage

• SCM is the managerial use of cost information explicitly directed at one or more of the four stages 
(strategy formulation, communicating the strategy, implementing and controlling) of strategic 
management

– Overall recognition of the cost relationships among the activities in the value chain, and the 
process of managing those cost relationships to a firm's advantage
 How to solve this case?

“My team has created a very innovative solution, but we’re still looking for a 
problem to go with it.”
 
Problems identified:
•We have solutions, but we have a problem in fitting the correct solution

•Lack of inwith the system and the synchronization with central theme of the 
Organization / Projecttegration
 SCM is the best solution
•Cost analysis in terms of overall value chain of which the firm is a part
•Strongly external focus
•The design of cost management systems changes dramatically
depending on the basic strategic positioning of the firm
Cost leadership or
Product differentiation
•Cost is a function of strategic choice about the structure of how to
compete and managerial skill in executing the strategic choices
Structural cost drivers and
Executional cost drivers
•Strategic cost management is a blend of
1. Value chain analysis (how we organize our thinking about cost
management?)
2. Strategic positioning analysis (what role does cost management play in
the firm?)
3. Cost driver analysis
 Value chain analysis

•Organize our thinking about cost management

•A Systematic approach to examining the development of
competitive advantage
•The chain consists of a series of activities that create and build
value
•They culminate in the total value delivered by an organization
•Helps to determine which type of competitive advantage to
pursue, and how to pursue it
•Value is referred to as the price that the customer is willing to
pay for a certain offering
 Value chain – all it means 
External focus perspective, linked with activities from raw material suppliers to 
ultimate end user
 
•Multiple cost driver concept
• Structural drivers (scale, scope, experience, technology, complexity)
• Executional drivers (participative management, TQM)
•Cost containment is a function of the cost drivers regulating each value activity
•  Exploiting linkages with suppliers, customers and process within the firm
•Insights for strategic decision by
• identifying the cost drivers at the individual activity level
• Develop drivers by controlling those drivers better than competitors or by 
reconfiguration of value chain
• Quantify and asses stake holders power and exploit the linkages
Source: Adopted from Porter's 5 force model (Competitive Advantage 
(1980).
Strategic positioning – all it means 
•Depends on the firm’s idea, how to compete?
         Cost leadership
          Product differentiation

•Cost leadership
         Mature market
         Commodity business
         Target cost

•Product differentiation
         Market driven
         Rapidly growing market
          Fast changing business
•Effective control system should be implemented to monitor the cost
Different cost and different strategy 
 Cost Driver strategy 

• Third key to strategic cost management

• Output cost is seen to capture very little of the richness of the cost
behavior
• Cost drivers in SCM can be classified as
o Structural drivers
o Executional drivers
• Structural cost drives the product cost of the organization
o Scale: how big an investment to make in manufacturing, R&D, and
in marketing resources?
o Scope: Degree if vertical integration
o Experience: how many times in the past the firm has already done
what it is doing again?
o Technology: what process technologies are used at each step of the
firm’s value chain?
o Complexity: how wise a line or products of services to offer to
customers? (usage of ABC)
 Cost Driver strategy (continues)…
 
•Executional cost determines the firm’s cost position to execute the strategy successfully
•These cost drivers are scaled with the performance
•Basic executional drivers
• Work force involvement (participation) – workforce commitment to continual 
improvement
• TQM, Capacity utilization, Plan layout efficiency and Product configuration
•For strategic analysis, volume is usually not the most useful way to explain cost behavior
• In a strategic sense, it is more useful to explain cost position in terms of the structural 
choices about executional skills that shape the firm’s competitive position
•Not all the strategic drivers are equally important all the time, but some of them are very 
important in every case
•For each driver there is a particular cost analysis frame work that is critical to 
understanding the positioning of a firm
 Tools n SCM 
Tools Nature
Value chain analysis Add value to customers reducing costs, and understanding relation between

business organization and booth customers

Activity based Costing (ABC) To provide accuracy in allocating indirect costs.

Competitive Advantage Analysis Defining strategy that an organization could adopt to excel over rivals

Target costing Cost that an organization is willing to incur according to competitive price that

could be used to achieve desired profit

Total quality management (TQM) Adopt necessary polices and procedures to met customers expectations

Just-in-time (JIT) A comprehensive system to buy materials or produce commodities when needed

in appropriate time
SWOT analysis Systematic procedure to identify critical success factors of an organization

Benchmarking Process performed to determine critical success factor and study ideal

procedures of other organization in order to improve operations and dominate

market
Balanced scorecard Accounting report of critical success factors about the organization. It is divided

into four major dimensions: financial performance, customers’ satisfaction,

internal operation, and innovation and Growth

 Tools n SCM 

Tools Nature

Theory of Constraints A tool to improve rate of transferring material into finished goods

Continuous improvement (Kaizen) Conducting continuous improvements in quality and other critical success

factors
Tools used for Value 
chain analysis 
A firm can create a cost 
advantage by 2 ways
 
Reducing the cost of 
individual value chain 
activities
 
Reconfiguring the value 
chain
Tools used for Value 
chain analysis 

Some of the tools used to 
find cost in value analysis 
are

 
Lifecycle costing

Supply chain management

Return on Asset

 Discounted cash flow 
analysis
Life cycle costing